Shortly after the market opened on Monday I took this screen shot of the Vanguard S&P 500 ETF (VOO) along with a bunch of derivative income funds that one way or another base off the S&P 500. I should note that ISPY is in my ownership universe.
The term 'downside protection' is often included in the marketing of these funds. Today was a great example of why that is a bad expectation to have, or I should say an unreliable expectation to have. You can see that the OVL print is actually from Friday. ISPY being down 40 fewer basis points might just be one of those things sort of luck.
With covered call funds, the upside is capped by the income producing act of selling calls. There is nothing in that strategy that stops the fund from dropping in line with the broad market on a day like Monday.
I do believe that it is possible for some of them to offer decent upcapture, smooth out the ride some and add some income to a portfolio but not all of the funds will do that. If you can find one with those three attributes, I would only use it as a satellite holding not a core holding. We've looked at examples of 90% into a plain vanilla S&P 500 paired with a 10% weighting into a covered call fund as a way to add some income and possibly reduce the volatility by just a little bit.
Here's the same screen shot at the close.
Generally a few basis points of outperformance today which is not negative with the proper context. These being down 1.50% in a down 3% world isn't going to happen very often. Today's result is also a microcosm for showing these funds are not fixed income substitutes either.
Today really hits the point of understanding what to expect out of a fund or strategy.
MRGR is the ProShares Merger Fund. Merger Arb being pretty flat makes sense, that met expectations. We've talked about BTAL and CBOE both having crisis alpha attributes, and while both were up today, they were each up more at the start of the day. Both of them are in my ownership universe. DBMF is a managed futures fund, all of the funds pretty much are getting hit hard through this event, the market moves of the last few days have been faster than the trend following used by managed futures.
Interestingly, the Alpha Architect Tail Risk ETF (CAOS) did a good job, going up 1.95%. The fund owns the BOXX ETF, client holding, with a put option overlay that is more involved than just buying puts and letting them bleed away the NAV of the fund. Many of the short term fixed income/cash proxies we look at for blogging purposes and that I own for clients had relatively rough starts to the day but they figured it out to mostly be either side of flat.
It is worth saying that the conversation we have here about portfolio construction is not aimed at how the portfolio will do today or this week but more like over full stock market cycles. Eyeballing client holdings, it looks like just two names were up, CBOE and BTAL, maybe half were down less than the market and so that means quite a few down worse than the market today. As a matter of luck, the portfolio has held up better despite a mixed result from the alt strategies, but there will absolutely be events in the future where that is not the case.
The takeaway is to build a portfolio that is valid, that you are confident in and that you can live with on the occasions when it has a relatively weak run. Every great portfolio will at times struggle. If you can understand when it might struggle all the better but it will surprise/disappoint occasionally.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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